In the world of accounts receivable (AR), your department serves as the lungs of your business, ensuring fresh cash flows to where it needs to go. And just as oxygen is essential for life, cash flow is vital for business survival. For B2B companies that primarily operate on credit terms, understanding your available cash and overall financial health is crucial. This is where Days Sales Outstanding (DSO) becomes your most valuable vital sign.
Understanding DSO: Your Financial Health Indicator
Days Sales Outstanding, commonly known as DSO, measures the average number of days it takes for your company to collect payment after making a sale on credit. Think of it as your business’s collection efficiency score – a lower number indicates faster payment collection, while a higher number suggests it’s taking longer to convert sales into cash.
Since the onset of the pandemic, this metric has gained even more significance. According to McKinsey’s recent survey, 65% of CFOs report more frequent engagement with their CEOs about company performance. With increased pressure to provide insights on working capital, tracking DSO has become more critical than ever.
The Science Behind DSO Calculation
Calculating your DSO involves a simple yet powerful formula. For a given period, you’ll need two key pieces of information: your total receivables and total net credit sales. Remember, we’re only interested in credit sales here – cash sales are collected upfront and effectively have a DSO of zero.
The formula is straightforward: divide your total receivables by total net credit sales and multiply by the number of days in the period you’re measuring. For businesses affected by seasonal fluctuations, quarterly calculations often provide more meaningful insights than monthly ones.
For example, consider a business with $80,000 in net credit sales over three months and $45,000 in total accounts receivable. Their DSO would be 51 days – meaning it takes them, on average, 51 days to collect payment on their invoices.
What Constitutes a Good DSO?
According to the Credit Research Foundation’s National Summary of Domestic Trade Receivables, the median DSO across industries in Q3 2021 was 37.69 days. However, what’s considered “good” varies significantly by industry. Healthcare companies might target 40-50 days, while manufacturing businesses often aim for 30-45 days.
Rather than focusing solely on the number itself, it’s more valuable to track trends in your DSO over time and compare yourself to similar companies within your industry. This provides a more meaningful context for your performance.
Understanding High DSO: Causes and Implications
A rising DSO can signal several underlying issues. It might indicate customer dissatisfaction, resulting in delayed payments. Alternatively, it could suggest that credit is being extended to customers who aren’t creditworthy. According to a recent PYMNTS and American Express survey, businesses relying on manual AR processes typically experience 30% longer average DSO compared to those utilizing AR automation.
The Path to Improvement: Strategic Approaches
Improving your DSO requires a strategic approach focused on several key areas. First, enhance visibility by giving customers easy access to their current and past invoices. Today’s B2B customers increasingly prefer digital payment options – make it convenient for them to pay you.
Consider implementing early payment incentives through strategic discounting. While managing discount eligibility traditionally has been challenging, modern AR automation platforms can streamline this process significantly.
Automated payment reminders serve as gentle nudges to busy AP teams, increasing the likelihood of timely payments while preserving customer relationships. Setting up autopay options can further streamline the collection process, ensuring consistent, timely payments.
Regular evaluation of customer creditworthiness remains crucial. Not every customer will be the right fit for your credit terms, and identifying at-risk accounts early helps maintain healthy cash flow.
The Future of DSO Management
While DSO is an invaluable metric, it’s important to recognize its limitations. It only considers credit transactions, can be influenced by revenue changes, and may be affected by seasonality. That’s why modern businesses are increasingly turning to comprehensive AR automation platforms that provide deeper insights and more efficient collection processes.
A modern approach to DSO management combines traditional financial wisdom with technological innovation. By leveraging automation while maintaining strong customer relationships, businesses can optimize their collection processes and maintain healthy cash flow.
Ready to transform your approach to DSO management? Let us show you how ÉquiSettle’s modern AR automation platform can help you achieve better control over your collections while strengthening customer relationships.